Do you ever wonder how your monthly mortgage payment is calculated?
…I am buying a house and received a huge package of disclosures from my lender. There’s an amortization schedule table in there with a ton of numbers. My lender said it’s just standard procedure to send them and for me not to worry. Do I need to care about this? And why is less of my money going towards principal at the beginning? Is it their tactic to make more money?
– Writes Kathy
Participants of an amortizing loan (aka a fixed rate mortgage) should get to know the amortization schedule, a table that details each periodic payment and how much of it gets applied to the principal and interest. In order to illustrate what this schedule tells us, let’s start off with an example. A $100,000, 30-year fixed loan at 5% interest will have the schedule as follows:
|Pmt||Principal||Interest||Cum Prin||Cum Int||Principal Balance|
The amortization schedule also tells us that the monthly payment is $536.82, in addition to the amount going towards principal and interest.
The nice thing about this type of loan is that payment is fixed over the entire length of the loan, which makes budgeting much easier. Otherwise, it would be difficult to feel secure knowing that such a big expense each month can fluctuate wildly.
Paying More Interest At The Beginning
Many will be quick to point out that most of your payment at the beginning really only goes towards interest. Don’t worry though. You aren’t being scammed here. Your mortgage rate is fixed, and when the principal is high, the interest is in turn higher at the start. In the above example, you owe $100,000 at the beginning, so the interest you need to pay is a little under $5,000 for the first year. If the monthly payment is $536.82, it’s only natural that most of your payment goes towards servicing the interest. By payment 349 (the last year of your 30 year fixed rate loan), your remaining principal is only $5761.26 and your interest is less than $300. With the same payment of $536.82, most of your payment will be applied to principal.
Paying It Off Early and Your Monthly Obligation
For those who like to pay off their mortgages early, note that the amortization schedule changes as soon as you put more towards your principal than the schedule suggests. There’s a caveat here though. Most lenders will not change your monthly payment obligation immediately following a mortgage prepayment. Here’s what I mean. Using the same example, say you got a bonus and want to apply the $10,000 towards your mortgage. You’d think that as the principal balance drastically went down, your monthly payment should decrease as your amortization schedule is re-calculated. Not so. Many lenders claim that you can get the new (lower) monthly payment if you call to request it, but again, you need to ask, and someone over at the lending facility need to say yes. Otherwise, you still need to pay that $536.82 until your loan balance is $0.
Therefore, paying more than you owe on your mortgage means sending in less (number of) checks in the future, but it doesn’t necessarily mean sending in smaller (lesser amount) checks in the future. Note the difference and plan accordingly before you mindlessly believe that you are always safe prepaying your mortgages.
Whenever rates drop, the ads for refinancing start popping up. The idea of it is to reduce your monthly mortgage payment, but it’s not necessarily a good thing. Sure, you can reduce your payment if the interest rate goes down, but some people also increase the length of their loan. There may be reasons why you would want to do that, but you are for sure paying more interest by doing this. In these instances, an amortization calculator would be helpful because it will show you exactly how much more interest you would be paying.
A Quick Note of Where to Find a Amortization Calculator
To get the numbers in the above example, all I did was a quick search on Google with the search terms “amortization calculator”. All the ones I’ve checked out work, and pretty much provide the same information. Alternatively, those of you who have Microsoft Office can also download their amortization schedule template straight from its official site.
It’s More Than For Fun
Sometimes, seeing these numbers are interesting but the amortization schedule serve a more important function. When I was contemplating all the mortgage options available, I used the calculator to figure out how much of a difference the rates made, and picked the one that I felt gave me the most bang for the buck. At the end, I picked a higher interest rate that gave me a huge up front credit towards closing, which would’ve never made sense if I didn’t have access to the different schedules.